Penumbra

Penumbra reported second-quarter revenue of $390 million, a reported increase of 15% year over year. Quarterly spending on selling, general, and administrative expenses rose 24%, which drove operating margin down by 150 basis points, compared with the prior-year period.

Why it matters: We think robust demand for Penumbra's thrombectomy and embolization/access devices holds few implications for the firm since its acquisition by Boston Scientific, likely to close by end-2026. However, we interpret ongoing double-digit growth in these markets as highly attractive to Medtronic, Stryker, and Boston Scientific—all of which have been beefing up their peripheral mechanical thrombectomy technologies. Moreover, we think there are large unmet needs in the peripheral vascular market that go beyond mechanical thrombectomy, which is why intravascular lithotripsy has also been a hot area for these competitors.

The bottom line: We're leaving our fair value estimate for Penumbra at $355, which reflects Boston's $374 offer price discounted by the cost of capital from the present time until the deal is expected to close at end-2026. Though we hadn't yet awarded Penumbra a moat last year because it hadn't climbed into the black, we did see inklings of a narrow moat in the firm's intangible assets. Now that Penumbra is moving into profitable territory, we think it's getting closer to a narrow moat.

Big picture: In recent years, some major medical device firms have turned their attention to underpenetrated markets such as pulmonary embolism and deep vein thrombosis. Because minimally invasive neurovascular platforms were already in use for ischemic strokes, it's not surprising to see Boston, Medtronic, and Stryker make moves to apply that technology in other areas of the body where blood clots cause problems. With Boston and Stryker's purchases of Penumbra and Inari Medical, respectively, we think this thrombectomy technology will get into more hospitals over the next five years.

We're holding steady on our $355 fair value estimate as the deal approaches completion. This is pegged to Boston Scientific's purchase price of $374 per share, discounted by the cost of capital from when the deal is expected to close by the end of 2026.

However, we have raised our stand-alone valuation of $249 per share, up from $226, after incorporating our new cost of capital methodology, which lowered the weighted average cost of capital to 8.5%, down from 9.0% previously. Our assumptions about Penumbra's business are unchanged. We assume Penumbra can continue to gain market share in peripheral thrombectomy and embolization, further penetrate the venous market, and leverage its first-to-market position for the use of CAVT in ischemic stroke. This translates into 12% average annual revenue growth through 2030, and corresponding average EPS growth of 16% annually over our explicit forecast period.

As unit volume increases, we estimate Penumbra can raise gross margin by roughly 400 basis points to 71% by 2030. This would put Penumbra’s gross margin closer to the typical range we estimate for endovascular devices. Further, we project operating margin to rise by 500 basis points to 18.5% over the next five years, as the salesforce becomes more productive, partially offset by increased research and development spending to support the expansion in the product portfolio and indications. If adoption of mechanical thrombectomy for underpenetrated markets, such as pulmonary embolism and deep vein thrombosis, rises faster than expected, this would add upside to our intrinsic value.

Though Penumbra has reached that inflection point where it is expected to tip into accelerating profitability, we remain in wait-and-see mode. As we’ve seen with other medical device firms in the early stages of commercialization, the path to economic profits can take five to 10 years. Moreover, that path isn’t always smooth, and it’s not unusual to see two steps forward and one step back. Penumbra had been making gradual progress toward this goal, but both the pandemic and mergers and acquisitions activity have weighed on this process in the 2020-24 time period.

Nonetheless, we think conditions are favorable for Penumbra to dig a moat. As with its larger competitors in the medical device industry, Penumbra could eventually develop intangible assets that would be substantial enough to support the generation of economic profits over the 10-year time period that defines a narrow economic moat.

We think there is potential to deepen the firm’s intangible assets. At present, Penumbra enjoys some intellectual property that includes approximately 175 patents granted and pending—of those, just under 90 are in the US. This growing layer of intellectual property lays the foundation for the firm to partially shield itself against competitive encroachment.

However, we note that the patents covering medical devices are not as airtight as the composition-of-matter patents that protect small molecule drugs. This means that device makers can more easily innovate their way around competitive patents. It is not unusual for different device manufacturers to offer devices that treat the same condition but that are somewhat differentiated and covered by different patents.

Having said that, we have seen situations where device makers wrangle over the patent protection and, in some cases, courts have ordered one firm to compensate its competitor for patent infringement or have slapped an injunction on sales of a product deemed to have infringed on a competitive patent. Thus, we think intellectual property in medical devices offers moderate protection.

Another intangible asset that device makers can cultivate is a salesforce that forges strong relationships with the physicians who make the brand choice. Again, Penumbra is already on this path, as it has created a commercial organization composed of sales reps that market directly to practitioners in the developed markets. With medical devices, these sales reps tend to be relatively highly trained in the narrow use of particular devices and procedures. They also serve as a source of continuing education about new technology platforms or improvements to practicing physicians.

Unlike some other medical devices that are insulated by switching costs, we don’t think Penumbra’s thrombectomy and embolization products offer much in this area. With cranial thrombectomy, studies suggest acceptable competence is reached with 50 cases. For embolization, we think the learning curve is slightly longer—general competence comes at 50 cases and expert competence at 100 cases.

Further, we view the competitive thrombectomy and embolization products as more similar than different from each other. All this suggests Penumbra’s devices do not have the onerous learning curve that characterize orthopedic joint replacements, for example, and would probably be more interchangeable than knee or hip replacements across vendors.

Penumbra’s products are also different from cardiac rhythm management and neuromodulation devices where the generator and connecting wires (which are implanted into brain or heart tissue) are designed to operate as a system. Thus, when the generator battery needs to be replaced every seven to 12 years, practitioners typically opt to use a replacement generator from the same company to match the wires that are already implanted and to reduce the risk of system dysfunction.

Sustainalytics views Penumbra’s ESG risk as low, and we concur. The most material risk centers around product governance. Product defects could lead to recalls that would hurt Penumbra’s business. However, the firm competes in markets that are already relatively consolidated. Further, there’s a good chance that Penumbra could reengineer its product to address defects. We think these two factors give Penumbra a fairly solid chance to withstand a recall in the near term and recover its business in the longer term.

Penumbra’s computer-assisted vacuum thrombectomy, Lightning Flash, offers leading-edge technology that minimizes patient bleeding and whittles down procedure time.

Since launching its first aspiration catheter for ischemic stroke in the US back in 2008, Penumbra has followed with a steady stream of innovative products.

Many of Penumbra’s devices are aimed at therapeutic areas where patients are untreated or undertreated.

Rival Stryker’s recent acquisition of Inari Medical means Penumbra will be going head-to-head with a formidable rival in peripheral thrombectomy.

Compared with other medical devices that may enjoy switching costs, Penumbra’s thrombectomy and embolization technology doesn’t seem to have a long learning curve.

Not only does Penumbra compete with other firms with mechanical thrombectomy technology, innovations in pharmaceutical thrombolytic agents could also eat into its primary business.